Do YOU Know What Provisional Income Is?

6a017c332c5ecb970b019104599445970c-320wiIf your retirement is still ten years or more in the future, NOW is the time to get your ducks lined-up.  Don’t wait until you’re at the doorstep – and, here’s why:

You may think you’ll spend less in retirement – that’s what all the experts say – but, if you’ve been a disciplined saver and investor with a nice nest-egg, you’ll probably want to enjoy life!  You may travel!  But, even if you don’t, here’s what you need to know:

You’ll probably lose some deductions.

Four deductions typically lost are:

  •  Mortgage interest
  •  Dependent Children
  •  Retirement Plan  Contributions
  •  Charitable Gifts

For most retirees, that leaves them with the standard deduction and personal exemptions.  Currently, for a married couple filing jointly, the standard deduction is $12,600.  Personal exemptions for each are $4,000; so, that gives a couple a total of $20,600 in deductions they can take when they’re no longer itemizing.  Historically, these have been adjusted for inflation, so you can do the same as you estimate what they’ll be in retirement.

So, any income below that number won’t be taxed.  But, what if income is higher? – and it probably will be.

The IRS looks at Provisional Income.  And, here’s what’s counted:

  • 1/2 of Social Security income
  • Distributions from tax-deferred accounts (your retirement accounts)
  • 1099 interest from taxable accounts
  • Employment income
  • Rental income
  • Interest from municipal bonds

Did you notice?  Municipal bond interest, which is normally tax-free, is counted!

What’s the significance of provisional income?  The total determines how much of your Social Security benefit gets taxed!    Here are the brackets:

Married Couples

Single People % of Social Security Subject to Income Taxation
< $32K <$25K 0
$32 – $44K $25 -$34K 50
> $44K > 34K


Here’s the kicker:  These brackets were created by President Reagan and House Speaker “Tip” O’Neil back in the early 1980s in an effort to save Social Security.  But, just a swith the Alternative Minimum Tax (AMT), they made no provisions for inflation adjustment.

That means inflation alone may force many into the higher brackets by the time they retire… a land-mine you need to be aware of.

What does all this mean for your advance planning?  It means you need to understand two things:

  1. Asset allocation decisions – the arrangement of assets – shouldn’t be limited to simply choosing a risk-adjusted allocation of asset classes and picking investments.  Before that stage, you must arrange assets – well in advance of retirement – into the right tax buckets.
  2. You (your advisor) will need to do some “reverse engineering” to guard against your provisional income in retirement exceeding your standard deduction and personal exemptions.  Example:  if you plan to retire ten years from now, those deductions should total about $27,700, using a 3% inflation factor.  So, for planning purposes, we’ll want to arrange assets into the right tax buckets well in advance to keep provisional income below that number.

How you should approach this strategy depends on too many variables to go into here – but, it should be a component of an overall financial plan for your life.

If you’d like help, feel free to contact me – there’s information below.

Hope this helps!